Materials ETFs Show Signs Of Life

The Materials Select Sector SPDR XLB and other materials exchange-traded funds struggled to start 2018, but the group has recently shown signs of perking up.

Last week, XLB gained about 3 percent, pushing its June gain to 4 percent, a move that's erased a year-to-date loss.

What Happened

Earlier this year, the materials sector struggled following the Trump Administration's tariff push and speculation that global trade wars were imminent.

“Increasing political tensions across major world markets are beginning to feed through to producers in the US,” said Markit in a recent note. “Greater speculation regarding metal prices and lower global demand for US manufactured goods has dropped the basic materials sector into a lower gear. That said, as the rhetoric regarding a 'trade-war' appears to be fading, the effects are also expected to subside.”

XLB, which tracks the Materials Select Sector Index, provides exposure to “chemical, construction material, containers and packaging, metals and mining, and paper and forest products industries,” according to State Street Global Advisors (SsgA).

Why It's Important

Demand conditions are improving as are new orders, but there's still some uncertainty surrounding materials companies due to tariff issues.

“Recently introduced tariffs on global imports of steel and aluminium by the US (exempt for the EU until 1st June 2018) have sparked retaliation from key export partners, with initial trade talks breaking down,” said Markit. “This comes at a time when global demand for inputs is already strong. Higher resulting import prices have impacted US firms' balance sheets and added pressure to supply chains. Both input costs and output prices have consequently risen sharply throughout 2018 so far.”

XLB's 24 holdings include only U.S.-based companies. DowDuPont Inc. DWDP is the ETF's largest holding at a weight of 24.36 percent. That is more than triple the weight assigned to XLB's second-largest holding.

What's Next

Data suggest input prices for materials firms are declining while output prices are surging. The specter of retaliation from U.S. trading partners could force some materials producers to scale back on growth projects.

“Over the last few years chemicals manufacturers have been investing heavily in new facilities and capacity expansion,” according to Markit. “Such large investments have left the sector vulnerable to recent metal price hikes, notably steel used in the construction of these plants, which is expected to hit profit margins. If such expenditures are to remain viable and tariffs were to continue, domestic customers are likely to need to fill the gap that a loss of global demand could leave.”

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